Returning to fundamentals

Market analysis
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4/27/2018

After weeks of investors focusing on US-China trade tensions, markets are gradually returning to fundamentals, prompted by upbeat quarterly earnings and persistently good growth in both the US and Europe.

US companies have reported particularly impressive sales growth, a token of strong economic momentum and the benefits of the lower US dollar. And both US and European companies have posted surprisingly good earnings. In Europe, industrials, energy and basic materials have all reported particularly solid earnings growth.

Meanwhile, US confidence indicators like the Markit services and manufacturing indices remained on an uptrend. US GDP estimates for the first quarter also underline accelerating YoY growth. US 10-year Treasury yields reacted to this confirmation of the US economic cycle’s strength by popping over the symbolic 3% mark to 3.003% for the first time since 2014. And US 2-year yields hit 2.5% for the first time since September 2008.

At the same time, the ECB’s cautious tone after Thursday’s meeting caused some easing in eurozone yields and sent the euro lower against the US dollar. Our reading of the meeting is that, in spite of the status quo being maintained, Mario Draghi's prudent stance reflects weakening economic indicators and reduced concerns over protectionism. He said a more in-depth analysis of the situation was required.

European equities

Markets were hit after US 10-year Treasury yields broke above 3% mid-week but rallied when yields eased, and the US dollar rose against the euro. April’s eurozone PMI were satisfactory and buoyed by services which recovered to high levels. Nevertheless, the ECB said it still wanted to remain accommodating.

But the market's trend was dictated by more first quarter results, with gains for good performance and declines for disappointing figures.

Despite fewer business days, like-for-like growth was generally strong and helped offset a more negative-than-expected currency effect. Industrials, tech and luxury led gains.

Kering shone thanks to a 49% jump in Gucci’s sales. The group expects to see favourable leverage on margins and revised guidance on earnings sharply higher to +13% for 2018 and +11% for 2019. Safran's sales and internal growth both beat expectations and the group confirmed its top-of-the range guidance for 2018.

Spie also beat the consensus and reiterated its targets for 2018 of more than 7% sales growth and EBITDA growth of above 6%.

Carrefour signed a buying agreement with Système U and another deal with its trade unions. Atos enjoyed a 3.7% increase in quarterly sales on a constant currency basis and announced a cloud agreement with Google. AXA released the details on the IPO of its US affiliate. Enel sweetened its bid on Brazil’s electricity company Eletropaulo to above Iberdrola’s offer. Accor might acquire Mövenpick and its 80 high-end hotels. Vinci is to acquire Omers’ airport businesses, including 2 fully-owned airports (Belfast and Stockholm’s low-cost Skavsta), 3 other airport concessions and 4 airports which it manages.

US equities

Markets edged slightly lower over the period with the S&P slipping 0.1% and the Nasdaq down 0.4%. So far, the earnings seasons has seen companies beating estimates. At the same time, geopolitical risk seems to be dying out and macro data has been very positive.

US consumer confidence continued to flirt with all-time highs, coming in at 128.7 vs. expectations of 126. New home sales were up 4% in March and durable goods orders rose 2.6%, or more than the 1.6% expected. These upbeat figures caused a slight steepening in the yield curve with US 10-year Treasury yields briefly topping 3%.

Figures from tech giants like Google, Microsoft, Facebook and Amazon were much anticipated as investors are heavily overweight the sector. Facebook jumped 9% after reporting a 13% increase in daily users to 2.2bn. Amazon’s operating profits soared 40%, blowing past consensus expectations and even its own guidance. What’s more, its sales rose most in its most profitable businesses. Revenue at Amazon Web Services rose 49% YoY and the pace of subscriptions accelerated to +60%. In other beats, Microsoft gained on strong momentum in its Cloud business and Intel saw data center sales rise by a sharp 24%.

Out of the 250 companies to have reported so far, 226 have done better than expected and only 21 have disappointed. Aggregate EPS came in at $37.97, a 23.2% increase on the first quarter of 2017 and 5.3% better than expected.

In a slightly down week, energy, utilities, healthcare and property ended higher while industrials, materials, non-cyclical consumption and tech underperformed.

Japanese equities

Thanks to receding tensions in the Korean peninsula, Japanese stock prices (TOPIX) advanced 1.20% during the week. Financials were strong after US 10-year Treasury yields hit 3% and export sectors like autos also gained as the US dollar strengthened against the yen.

In sectors, Insurance (+4.29%), and Banks (+3.42%) outperformed the TOPIX. T&D Holdings (+9.15%), Resona (+6.66%) and DAI-ICHI Life Holdings (+6.36%) were among the top five TOPIX 100 performers. And a defensive sector like Electric Power & Gas (+4.29%) remained popular. Kansai Electric Power and Chubu Electric Power gained 4.65% and 4% respectively.

As the yen depreciated from 107 to 109, investors went for Tokyo Electron (+7.34%) and auto sector stocks such as Subaru (+4.24%), MazdaMotor (+3.60%) and Toyota Motor (+3.05%).

On a more negative note, Takeda Pharmaceutical sank 6.2% on concerns over its proposed mega-acquisition of Shire, a major Irish pharmaceutical company.

Emerging markets

China’s industrial profits growth slowed to +3.1% in March, down from +16.1% in the first two months. The trade war seems to be intensifying: last week ZTE was sanctioned for embargo violation and now Huawei is being investigated by the FBI over sales to Iran. We will find out more when the US Treasury secretary visits next week.

To help encourage 5G roll-out, China’s National Development and Reform Commission (NDRC) has halved the number of 5 licences. Baidu's first quarter results soared 138% or 54% more than expected. The outlook for growth in the second quarter is also better than expected. Ping An’s first quarter earnings grew 11% with good growth in fintech and healthcare services, but markets were disappointed by a decline in new business value (NBV). Tal’s sales jumped 59% in the last quarter with 96% growth in student numbers. Hengrui Medecine’s results were up 17% or slightly less than expected. China Construction Bank reassured the market by reporting a solid 5% increase in profits and a stable 1.49% cost of risk. Sands China's results were up 26%, or more than expected. Airtac’s results surged 40% despite a slight margin contraction. Samsung Electronics results rose by an impressive 52%, underpinned by tight memory supplies and better operating margins in smartphones after the Galaxy S9/S9+ launches. The buoyant memory market was also reflected in SK Hynix’s 64% increase in earnings.

Indian banks released robust results with HDFC Bank up 20% and a 29% increase for Yes Bank. Icici Prudential surprised markets positively as sales of protection plans gathered momentum. In Indonesia, Astra’s results remained weak with only 2% in annualised growth. Bank Central Asia’s results were up 10.4%, or in line. Yandex’s results soared 166%, or better than expected, thanks to limited losses in its on-line taxi reservation service.

In Brazil, Via Varejo reported 24% growth in EBITDA. Bradesco's results rose 9.7%, or slightly more than expected thanks to a decline in the cost of risk. In Mexico, Banorte’s results rose 22%, a positive surprise for markets.

Fears of a trade war and rising long bond yields will continue to increase emerging market volatility over the short term.

Commodities

Brent crude stabilised close to a lofty $75 and WTI ended at $69. They are expected to stay close to these levels up to May 12 when Donald Trump decides whether or not to stick with the Iran nuclear accord. The only reason that might encourage him to prolong the deal is the looming summit with North Korea’s Kim Jong-un which is scheduled for the end of May, or early June, at a location to be decided. The North/South Korea meeting is only the first step towards this summit, but it is a significant event.

Ultimately, however, it is somewhat unlikely that the US will maintain the nuclear accord and the rolling out of US sanctions would prevent many refineries from buying Iranian crude oil. That would take out 200-500,000b/d from an already stretched market amid further declines in Venezuela’s output and persistently strong global demand.

In China, for example, March demand rose by 500,000b/d over a year to 11.7 million b/d. Quarterly earnings reports from oil majors reflect the positive impact of high oil prices on profits and cash flow generation but also the contribution of investment discipline. First quarter capex actually came in lower than the budgeted annualised pace. Total, for example, invested $2.6bn compared to plans for €15-17bn this year and Shell $5.2bn compared to $25-30bn.

Only a few days after announcing sanctions against Rusal, the US administration said they might be withdrawn if its biggest shareholder, Oleg Deripaska, were to sell his 48% stake. Existing Rusal clients are also being given more time to reduce business with the company. But tensions on the aluminium market could well persist.

Corporate debt

Credit

High yield credit slipped over the week due to recent interest rate rises, strong primary activity and little action on the secondary market. The down trend was more marked among financials, partly because of slightly disappointing results from banks like Deutsche Bank. The ECB meeting yielded no surprises and had no big impact on spreads which tightened slightly.

Flora Food Group, sold senior 8-year maturities, a $525m tranche at 7.875% and a €685m tranche at 5.75%. Fedrigoni (B1/B+, high quality paper) raised €455m with a 6-year bond with a variable coupon. Atalian (B2/B+, facility services) sold a 7-year bond with euro and sterling-denominated tranches for a total of €610m and with yields of 5.125% and 6.625%.

France’s Peugeot (Ba1) posted satisfactory first-quarter results. Like-for-like sales were up but jumped 42.1% thanks to the integration of Opel. The group expects the European market to be stable in 2018 and reaffirmed its “Push to pass” plan’s objectives. Eurofins (laboratory testing) saw sales rise 23% last year mainly due to the acquisition of EAG in the US. Like for like growth in the first quarter was, however, only 4%, or less than the +7% in the fourth quarter and the +6% in the third. First quarter figures at Telenet (Ba3/BB-) missed expectations with sales up 1% and EBITDA 6% higher. But the group said it was still targeting stable sales and a 7-8% increase in EBITDA in 2018.

S&P downgraded the outlook for Casino (Ba1/BB+) from stable to negative, citing increased debt in 2017 which prevented the group cutting leverage to below 4.4 times. But by not downgrading the credit rating; S&P showed that credit ratios are expected to improve and there are also expectations of a positive contribution from recent alliances with Amazon and Auchan. In contrast, S&P upgraded FNAC Darty to positive due to upbeat operating results.

Convertibles

On the primary convertible side this week, the UAE’s London-listed NMC Health raised $450m with a 7Y 1.875% convertible for refinancing purposes. NASDAQ-listed Australian software company Atlassian raised $850m with a 5Y 0.625% convertible for working capital needs. JP Morgan issued another synthetic bond linked to Voya Financial shares. The bank is buying back $350m in convertibles issued in January and offering investors a $600m 5Y 0.25% coupon bond instead. AXA announced a mandatory $750m 3Y bond exchangeable into shares of its US affiliate AXA Equitable Holdings due to go public in the coming weeks. The proceeds will towards funding the XL Group acquisition.

On the earnings side, Fugro surprised on the upside first quarter sales of €350m, posting positive organic growth after 12 quarters. The company highlighted stabilizing offshore oil and gas markets and increased backlog, and the shares jumped 16%. Outokumpu disappointed investors with a weak second-quarter outlook and Americas division remained in negative EBIT territory at minus €6m. The shares declined 12.56%.

In Japan, CyberAgent posted strong second quarter results, beating estimates with EBIT up 44% YoY to JPY 11.5 bn due to strong internet advertising and robust sales in its gaming segment. In addition, Nintendo and CyberAgent announced a partnership to develop smartphone games, with the video games giant acquiring 5% of Cygames, Cyberagent’s gaming unit.

Despite record group operating profits for the year, Sony’s results were below estimates at JPY 734.86bn versus 743.23bn expected. More disappointing was the guidance for next year with sales in PS4, music, movies, mobile and home entertainment divisions all forecast to decline.

In the US, Citrix reported a very strong first quarter with revenues up 5% YoY thanks to subscription revenue growing 48% YoY. Semiconductor names AMS and Teradyne were punished by weaker orders from Apple for iPhones across the supply chain. Teradyne lowered its SoC test market forecast by 13% due to soft volumes, while AMS guided second quarter revenue down 48% QoQ.

The Steinhoff bond complex weakened this weak as ex-chairman Christophe Wiese announced claims against the troubled retailer for ZAR 59bn (€3.93bn) on the grounds of his holding Titan Group’s cash investments in Steinhoff in 2015 and 2016.